Beijing’s renminbi experiment

emerging market development

The standard road to economic development for emerging economies in the post-WWII era has been to emulate Japan …that is to say, to provide cheap labor and a supportive working environment to foreign firms in return for technology transfer.  To ensure the emerging country keeps its labor cost advantage, it typically pegs its currency to that of its largest target market (read: the US) or to a basket of currencies representing the bulk of potential customers.

As I’ve commented in more detail in other posts, the crucial testing point for this strategy comes when the emerging nation runs out of cheap productive resources.  Usually, the factor is labor–although it could equally be water or something else.  At this point, labor-intensive firms can no longer expand operations by turning farmhands into assembly workers.  They can only grow by poaching workers from each other, causing wages to rise and an inflationary spiral to begin.

letting the local currency rise

The orthodox solution to the problem is to dissolve the peg and allow the local currency to rise.  Doing so lessens or eliminates the labor cost advantage that has helped the emerging nation develop.  In theory, it also forces industry to evolve toward higher value-added production, and requires the labor force to learn new skills.  In practice, allowing the currency to rise is strongly opposed by industrialists who have become wealthy and politically powerful under the existing regime.

The rising currency solution has other characteristics, as well:

–overall growth slows, at least for a time,

–development reorients itself away from export-oriented manufacturing and toward the domestic economy,

–the real earning power of workers rises, but nominal wages do not necessarily change, and

–the real value of asset holdings increases for all.

This last characteristic is especially important.  In a rising currency environment, the wealthy make out like bandits.  Ordinary people get a boost to their earning power, but since they may not hold property or have a large amount of accumulated savings, they probably lose economic ground to the wealthy.

a different route

Of course, currency appreciation is not the only way to raise real wages.  Why not take the direct route and raise nominal wages?  Two considerations:  1) the mechanics of getting this done could be difficult, and 2) whoever mandates higher wages is clearly responsible for the consequences–there’s no possibility of blaming evil currency speculators for any negative effects.


I can think of only one instance where an emerging nation tried this route.  Decades ago, when Singapore was primarily a textile manufacturer, the government there raised the cost of labor–through an increase in mandatory employer contributions to the government-run pension plan.  Singapore wanted to encourage higher value-added manufacturing.  What it got instead was textile firms fleeing and a recession–which lasted until the government rescinded the pension payment increases.

Hong Kong

Hong Kong might be seen as another case in point, although the currency peg there was instituted as a political measure–to lessen flight capital in advance of the handover of the former British colony back to Beijing–not an economic one.

The Hong Kong experience, created more by necessity than economic planning, had several important characteristics:

–economic/mobility increased significantly; power shifted quickly from the existing, mostly British, elites to new, mostly ethnic Chinese, players ,

–Hong Kong was forced to become a cauldron of entrepreneurial development, just to deal with the pressure of rising wages,

–nearby Guangdong province benefited greatly from the shift of more labor-intensive manufacturing there.


The large across-the-board wage increases for ordinary workers recently mandated by Beijing seem to me to be the clearest signal that China has decided to try to duplicate the beneficial effects of the Hong Kong currency peg.  The eastern seaboard will play the role of Hong Kong, western China that of Guangdong, and the “princelings,” the sons and daughters of former Communist Party leaders, that of the British.

The development of the offshore renminbi market may be a new twist in the plot, but I think that otherwise the story remains the same.  If this is correct, calls for Beijing to allow the renminbi to rise against the US dollar will continue to fall on deaf ears.  From a stock market point of view, the interesting consequence might well be surprisingly strong spending by middle- or lower-end consumers.  The big question is whether to play this through already prosperous retailers or to look for the emergence of new concepts tailored specifically to this audience.  The latter route promises much bigger payoffs; the big problem is identifying the correct stock/stocks to buy.


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